Foreign Aid, Debt and Growth in Zambia

137 Pages·2005·8.58 MB·English

Research Report No 112

Per-Åke Andersson
Arne Bigsten
Håkan Persson

FOREIGN AID, DEBT AND GROWTH IN ZAMBIA

Nordiska Afrikainstitutet
Uppsala 2000
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Indexing terms
Development aid
External debt
Economic development
Investment
Zambia

Language checking: Elaine Almén

ISSN 1104-8425
ISBN 91-7106-462-1
© the authors and Nordiska Afrikainstitutet 2000
Printed in Sweden by Motala Grafiska, Motala 2000
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Contents
Preface 5

List of Acronyms 6

1. Introduction 7

2. Macroeconomic Framework 9
2.1. Introduction 9
2.2. Colonial Background 10
2.3. Ten Years of Relative Prosperity, 1964-1974 11
2.4. Shocks and Decline 1975-1980 16
2.5. A Lost Decade, the 1980s 19
2.6. Adjustment at Last, the 1990s 21
2.7. Economic and Social Outcomes 28

3. Aid and Foreign Debt 30
3.1. Introduction 30
3.2. Cross-Country Evidence on the Impact of Aid on Growth in Africa 30
3.3. The Zambian Case 35
3.4. Foreign Aid Flows to Zambia 38
3.5. The Debt Problem 44
3.6. Can Aid Be Growth Generating? 47
3.7. Concluding Remarks 51
Appendix 3A: The Donor-Recipient Relationship 52

4. Determinants of Investment 56
4.1. Introduction 56
4.2 Macroeconomic Reforms and Economic Outcomes in Africa 56
4.3. Adjustment and the Determinants of Private Investment 67
4.4. The Business Environment and Private Investment 70
4.5. Investment in Zambia 74
4.6. Summary and Policy Conclusions 77
Appendix 4A: Macroeconomic Reforms and Investment 79
Appendix 4B: Adjustment and Investment in Selected African Countries 80
Appendix 4C: Investment Behaviour in Manufacturing Firms in Africa 82
Appendix 4D: Africa’s Tiny Share of Foreign Investment 83
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5. CGE Models for Investment Analysis 85
5.1. Introduction 85
5.2. The Neo-classical Model 85
5.3. Application of the Neo-classical Model 86
5.4 The Structuralist Model 87

6. Policy Analysis 88
6.1. Introduction 88
6.2. The Base Run with the Neo-classical Model 88
6.3. Foreign Loans to the Private Sector plus Amortisation 91
6.4. Foreign Aid to the Public Sector 93
6.5. Investment Aid to Agriculture 95
6.6. Investment Aid to Manufacturing 97
6.7. Investment Aid to Mining 99
6.8. Price Boom in Mining 101
6.9. A Sensitivity Test Using the Structuralist Model 103
6.10. A Comparison of Policy Impacts 104
Appendix 6A: Comparisons across Experiments 107

7. Summary 109

References 112

Model Appendix: CGE Models of the Zambian Economy 120
1. The Neo-classical Model
1.1. Production
1.2. The Physical Balance Equation
1.3. Prices, Wages and Profit
1.4. Export and Import
1.5. The Government Budget
1.6. Private Consumption and Saving
1.7. Investment
1.8. Calibration of Production Parameters
1.9. Nested Labour Relations
1.10. Calibration of the Linear Expenditure System
1.11. The Structure of the Model
1.12. Data
2. A “Structuralist” Model with Endogenous Capital Formation
2.1. Physical Balance Equation
2.2. Private Consumption and Saving
2.3. Public Demand
2.4. Export and Import
2.5. The Forecast Period and Investment
2.6. Labour Market
2.7. Prices
2.8. Solution Procedure
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Preface
This work was initiated in 1993, and we have over the years benefited from
the help and comments of many individuals. We gratefully acknowledge
assistance from officials of the Zambia government and the University of
Zambia. We have also received comments and help from Chris Adam, Dick
Durevall, Jörgen Levin, Steve Kayizzi-Mugerwa, Rick Wicks and NAI
referees. We also thank Eva-Lena Neth for assistance at the many stages of
this work. This study has been financed by grants from the Swedish Agency
for Research Cooperation with Developing Countries (SAREC) and the
Social Science Research Council (HSFR). We have also drawn on reports on
Zambia published by Sida in its Macroeconomic Studies series. In no way
are the people and institutions named above implicated in the shortcomings
of the study, which remain ours alone.

Göteborg, May 2000
Per-Åke Andersson Arne Bigsten Håkan Persson
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List of Acronyms
ASIP Agricultural Sector Investment Programme
CGE Computable general equilibrium (model)
CPI Consumer price index
CSO Central Statistical Office, Lusaka
DAC Development Assistance Committee of the OECD
EIU Economist Intelligence Unit
ERP Economic Reform Programme
GDP Gross domestic product
GNP Gross national product
GRZ Government of the Republic of Zambia
GTZ Deutschen Gesellschaft fur Technische Zusammenarbeit
HSFR Humanities and Social Sciences Research Foundation
IDA International Development Agency
IFIs International Financial Institutions (IMF, World Bank)
IMF International Monetary Fund
LDC Less developed country
M2 Broad measure of money supply
MMD Movement for Multiparty Democracy
MPC Marginal Productivity of Capital
NEP New Economic Programme
NERP New Economic Recovery Programme
NGO Non-governmental organisation
ODA Official development assistance
OECD Organisation for Economic Cooperation and Development
RAP Rights Accumulation Programme
SAP Structural Adjustment Programme
SAREC Swedish Agency for Research Cooperation with Developing
Countries
SDR Special Drawing Rights
UDI Unilateral Declaration of Independence
UNDP United Nations Development Programme
UNIDO United Nations Industrial Development Organisation
ZCCM Zambia Consolidated Copper Mines
ZNCB Zambia National Commercial Bank

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1. Introduction
During the 1980s and first half of the 1990s per capita incomes in Sub-
Saharan Africa fell by 1.3 per cent per year. Africa stands out as the worst
performing region in the world. African economies have invested a smaller
share of GDP than comparable regions, and a smaller share of investments
has gone to the private sector. One third of the growth gap vis a vis other
LDCs may be explained by lower investment rates, but the remaining two
thirds was due to slower productivity growth (Collier and Gunning, 1999).
Investment in Africa seems to be less efficient than investment in comparable
regions. It is estimated that incremental capital-output ratios are one quarter
of those in East Asia (before the crisis) and between half and two thirds of
those in other LDCs (Adam and O’Connell, 1997).
During the 1980s and 1990s African economies, including Zambia’s, have
undergone a series of structural adjustment programmes aimed at increasing
investment levels and improving allocation of investment resources.
However, the investment response to economic reforms has been poor,
largely due to the high risks associated with investment in Africa. High
uncertainty tends to make investors avoid irreversible investments. One
issue of interest in this context is to what extent foreign aid can help reduce
risks and increase stability. If aid can help guarantee stability, it may make
the countries more attractive to foreign or domestic investors. It has been
noted, however, that high aid inflows may have reduced the ability of
genuine reforming governments to signal their intentions of sustained
reform (Rodrik, 1989), which has meant that investor confidence has not
been built up. Other reasons for low investment during the reform period
may be that the countries started from a disequilibrium capital stock, that is,
one that was too large in some sectors, in the new economic environment.
Zambia is one of the worst cases of economic decline and build up of
foreign debt in Africa. Like most African countries, it has undergone a series
of adjustment programmes to restore economic equilibrium and growth.
There has been progress with regard to some macroeconomic balances such
as the external account, but there has not been any vigorous investment
response. The extra resources have primarily been used to restore the exter-
nal balance, and since Zambia had built up large foreign debts before the
adjustment efforts, most of the extra resources have had to be devoted to
debt service. This has meant that it has been very difficult to increase
domestic investment from the previous extremely low levels. How to
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achieve this is one of the most crucial questions with regard to the long-term
development.
Adjustment programmes in Zambia have regularly broken down. This is
partly due to domestic politics (Bates and Collier, 1993), but it is also due to
the impact of the extreme debt burden that overshadows all policy making
in Zambia. The crucial policy question in Zambia is thus how to handle the
issue of debt and make optimal use of aid so that investment activity can
resume. This is an extremely difficult question, but the revival of Zambia
depends on its resolution.
To address this issue one needs to understand the trade-offs involved,
and this requires a proper understanding of the functioning of the economy.
To analyse the impact on investment of more foreign resources or changes in
aid conditions, one needs a general equilibrium model of the economy,
which models investment behaviour properly. We will therefore construct a
model of the Zambian economy that is sufficiently rich in the specification of
investment behaviour so that it can be used to analyse the investment con-
sequences of, for example, different aid and debt options. The focus of the
study is our CGE-model, but we also analyse the major areas indicated
above. We start in Chapter 2 by reviewing the macroeconomic development
of Zambia since independence, focusing particularly on changes in policy
that are especially relevant for this study. In Chapter 3 we look at the role of
aid inflows in African economies in general, and Zambia’s in particular. In
Chapter 4 we do the same thing for investment. On the basis of our analyses
in Chapters 2 to 4 we then build our CGE-models. An overview of the
models is presented in Chapter 5, while the full technical description is
presented in a Model Appendix (see p. 120). The policy analysis is presented
in Chapter 6. We compare the results of policy strategies with different
financial restrictions, that is, with different assumptions about the avail-
ability of foreign resources through aid, loans, and export revenue. The fate
of export revenue is of course closely tied to what happens in the copper
market. Finally, Chapter 7 provides a summary of our results.
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2. The Macroeconomic Framework
2.1. Introduction
At independence in 1964, Zambia inherited a dualistic economy that was
heavily dependent on the mining sector for employment, foreign exchange
earnings and government revenue. Government policy was focused on this
sector, while traditional sectors, such as agriculture, were neglected.
Nevertheless, during the first decade of independence the country enjoyed
one of the highest rates of growth in Sub-Saharan Africa. Prices for its major
export, copper, were high and a relatively advanced manufacturing base was
developed through import-substitution. The political leaders were confident
enough to take over the main commercial and industrial undertakings. The
new political leaders developed a distinctive political/economic model
based on state-ownership and underdevelopment of agriculture. When the
world-wide recession of the 1970s hit Zambia, the model became increas-
ingly unworkable and mineral dependence proved a two-edged sword. Both
foreign exchange reserves and government revenue fell drastically. To
sustain the economic structures built up in the affluent 1960s, mining, the
main generator of foreign exchange, had to continue to receive the lion’s
share of domestic resources.
The transition from being one of the richest countries in Africa to one of
the poorest took less than a generation. On the eve of the multi-party
elections in 1991 real per capita income had more than halved since 1970,
gross national savings represented only 6% of national income, as opposed
to 18% in 1970, while gross investment had fallen to less than 10% of national
income, down from close to 40% in 1970 (Andersson et al, 1994). This result
was brought about by severe negative shocks combined with bad economic
management. The situation improved during the first years of the 1990s,
thanks to an orthodox structural adjustment programme. Today, there are
indications that the progress might be halted again. The political turmoil
after the second multi-party election in 1996 meant that the bilateral donors
froze their balance-of-payments support. The government has also been slow
to privatise the mining company, which is facing severe operational difficul-
ties.
This chapter analyses Zambia’s macroeconomic responses to economic
crises. The presentation is chronological and follows the sequence of
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measures taken to contain the economic decline. To put Zambia’s experience
in perspective, the second section looks at the country’s colonial legacy and
its social, political and economic impact. Subsequent developments are
discussed in the following four sections under four headings: ten years of
relative prosperity, 1964–1974; shocks and decline, 1975–1980; a lost decade,
the 1980s; and adjustment at last, the 1990s; respectively. The last section
summarises the outcomes in terms of incomes and some welfare indicators.
2.2. Colonial Background
The British South Africa Company handed over the administration of
Northern Rhodesia to the British Government in 1924 and copper mining
was embarked on in earnest a few years later. Its development was largely
left to transnational interests, involving South African, British and North
American companies. It was, however, not to take firm roots until the boom
years that followed World War II.
In relation to her southern neighbour, Northern Rhodesia was regarded
as something of a marginal colony. To ensure a cheap and plentiful supply of
labour to the mining industry, the colony’s traditional sectors were left
undeveloped. The social and economic infrastructure, the mining industry
apart, received low priority.
The years preceding the Second World War marked the beginning of
dualistic development (Baldwin, 1966, Blitzer, 1979). Mining was booming,
while the peasant sector tried to make ends meet under a lop-sided agri-
cultural legislation that favoured the small, but capital intensive, settler-
farmer enclave (Fry, 1979). Migration from rural areas to mining and com-
mercial agriculture was actively encouraged, while laws and other regula-
tions restricted alternative income-generating opportunities in traditional
agriculture and craftsmanship.
Probably the most important socio-economic impact of the mining sector
was the role it played in the evolution of an urban working class (Gertzel
and Szeftel, 1984). Miners became a ‘labour aristocracy’ with considerable
influence on the economy at large, most notably through their impact on
modern sector wages.
The colonial legacy may be summarised in five points:
1. A technologically advanced mining sector was developed into the
mainstay of the economy, thereby laying the ground for an almost irre-
versible external dependence. And since mining uses capital intensive tech-
niques, the sector could not be relied on to generate the employment that the
country yearned for.
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